Momentum Trading Strategies

Momentum strategies can be a very simple way to trade. As the saying goes. "buy it when it is going up, sell it when its going down".

A momentum strategy simply looks to go long when the price has gone up over X period of time, or short when the price has gone down in the same way.

This is also known as following the trend, although "trend" suggests a smooth and steady type of price movement.

You might ask, if momentum is so obvious, why do so many traders lose money by trying to trade breakouts or by following trends? The reason for this is because momentum over shorter time periods, such as a few minutes or hours, is unreliable. The kind of momentum that is worth looking for is when the price of something has been rising or falling over a period no shorter than at least a few weeks.

To test this concept, I conducted a couple of expirements. I looked at 24 of the most widely traded currency pairs over a period of roughly the previous 10 years. Here is what I found:

Experiment 1: if any pair went up or down over a calendar month, I would have opened a trade in the same direction and exited one month later. This would have meant 24 trades every month, of equal size: a total of 2,880 trades, which is a reasonably large sample. Surprisingly, the results were positive. 54% of the months were winning months, and the total performance was 205%. There were periods of huge losses, and I am certainly not recommending this as a strategy. What this proves, is that momentum can be a profitable strategy if it is defined as a price movement over a long enough period. The best results were achieved by defining the momentum up or down over a previous period of 3 months.

Experiment 2: looking at the same currency pairs as Experiment 1, I looked for the most strongly performing currency pair over the previous period, and traded only that in the same direction, holding for a period of 1 month as in the previous experiment. This is a total of only 120 trades. The results were also positive using momentum periods of 1 month to 6 months. Again, the best performing time period to use was 3 months, which gave a total performance of 57% with 55% of all months producing positive results. An interesting note: defining momentum by periods longer than 6 months produced negative results, so where a trend is long over 9 months but short over 3 months, you seem more likely to do better by following the 3 month trend.

I do not recommend following these strategies blindly, but rather to see whether something has been going up or down over these kind of periods, and using the result as one of the factors to consider when deciding which pairs to trade and in which direction.

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